Should I Prioritize Health Insurance Subsidies or Roth Conversions?

In this episode of Ready for Retirement, we’re talking about how to know whether you should prioritize health insurance subsidies or Roth conversions.

Questions Answered: 

• Should I prioritize health insurance subsidies or Roth conversations?
• When won’t these strategies be relevant?

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Episode Timeline:

04:33 – Key points to consider when approaching this topic

10:43 – When won’t this be relevant?

13:22 – The Solution

27:49 – Summary of key takeaways

Key Takeaways:

• Golden Question: 
  • Do you use the years in your tax planning window to keep income low to qualify for health insurance premiums OR do you keep income low to free up the ability to do Roth conversions at a lower tax bracket?
• Key Points to Consider
  • What is a tax planning window? A tax planning window is the period of time you’ll have a lower income or the option of creating a lower income, typically between the time you retire and the time that Social Security kicks in (at 70) and required distributions kick in (at 72). 
  • The benefit of prioritizing Roth conversions is to reduce the impact of RMDs at a later date and pay taxes at a lower tax bracket. 
  • The benefit of prioritizing health insurance subsidies is that they help to keep the cost of your health insurance low.
  • Everyone’s tax planning window is going to look different. Some might not have it, depending on when they retire, when they start Social Security, or their asset types. 
  • If you’re going to retire before 65, you have to determine how you’re going to pay for health insurance. Medicare doesn’t kick in until 65, so you’ll choose an option like COBRA or health coverage from your old employer, but for many, you’ll have to go out to the marketplace to buy health insurance coverage until Medicare kicks in.
  • If your household income is less than 400% of the federal poverty level, then you qualify for a health insurance subsidy.
• Why These Two Strategies Conflict One Another
  • Roth conversions increase your taxable income and your income is what’s going to determine your ability to qualify for health insurance subsidies.  
• When won’t these strategies be relevant?
  • If you’re retiring over the age of 65.
  • If you don’t have a substantial amount in your pre-tax accounts (rough estimate: < $500,000).
• The Solution
  • First, start with a basic projection of your required minimum distributions (RMDs). You can use software or a financial calculator.
  • Will RMDs be an issue for you? Meaning, does the amount have the potential to push you into a significantly higher tax bracket?
  • If RMDs won’t be an issue for you, the Roth conversions may not be the most effective choice for you. It might be more beneficial for you to keep your income low to qualify for health insurance subsidies.
  • If RMDs are going to be an issue for you, you need to understand how much money you could save by doing a Roth conversion strategy. Could RMDs be mitigated by starting conversions after 65?
  • You may be able to get the best of both worlds if the timing and numbers are right!
  • Are you charitably inclined? Do you want to give significantly to charities throughout retirement? Then your RMDs could be offset through Qualified Charitable Distributions (QCDs) and Roth conversions become less important.
• Summary – What to focus on moving forward
  • You need to weigh the financial impact of both of these strategies, given you’re retiring over 65 and don’t have a “substantial” amount in your pre-tax accounts.
  • Roth conversions have the potential to save you hundreds of thousands of dollars or even millions in taxes over the course of your lifetime (only if you have a substantial amount of money in pre-tax accounts).
  • Health insurance premiums have the potential to save you tens of thousands of dollars in expenses. 

Resources Mentioned:

FiPhysician: www.fiphysician.com

FiPhysician Article – “Choosing Between Premium ACA Tax Credits and Roth Conversions”: www.fiphysician.com/aca-tax-credits-or-roth

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